More and more Canadians are earning tidy sums playing poker on off-shore poker websites. They often practise incessantly, refine their skills using coaches and software programs, and participate in online forums dedicated to strategy. Many of these players spend 30 hours a week online playing against opponents from around the world.
At this time of year, winning poker players are reminded of a confounding tax position. Most Canadians believe, incorrectly, that lottery and gambling winnings are not subject to income tax. The conventional view is correct in that every budding poker player starts out playing casually and with "after tax" dollars. If a casual player wins, he wins without tax consequences; if he loses, he loses without tax consequences. At some point, however, under Canadian law, the tax consequences change for winning players.
Poker winnings are subject to tax if they are "income from a business." So when does playing winning poker amount to a business? The Income Tax Act doesn't provide an answer. And there's no reported case explaining precisely when the net winnings of individual poker players are subject to income tax. In the entire body of reported Canadian case law on the related question of the taxation of gambling winnings more generally, there are only a few cases where individual gamblers have been found to be in the business of gambling. The upshot for poker players is that it's probably in only unusually active, skillful and financially successful circumstances that they will face Canadian income tax liability on their winnings.
The central legal difficulty arises in determining at which point a taxpayer crosses the line from playing poker casually to playing professionally or as a business. Consider the incentives facing the player, and then the policy-maker.
A winning player would prefer to delay the transition from casual to professional. There's the "tax free" aspect, of course, and there's also not wanting to feel like a patsy by paying income tax when it's not legally required. There's a conflicting concern, though, facing a winning poker player. If that player takes too long in making the transition to professional, he may end up being subjected to back taxes, interest and penalties associated with not declaring poker winnings as income. That could prove extraordinarily costly and, in some cases, even lead to bankruptcy.
On the other hand, tax authorities shouldn't be in a hurry to single out winning players. Consider what happens if the casual enthusiast crosses the line to professional player before it's abundantly clear that he has, in fact, the requisite skill to be a winner. If the tax authorities are too aggressive in exacting income tax from winning players, they run the risk of too many losing players claiming they satisfy the conditions for being considered professional as well.
Under the Income Tax Act, an individual's losses from a business may be set off against income from other sources, such as salaries or wages. The limited case law shows that tax authorities have indeed been hostile to claims by taxpayers that they are professional gamblers in circumstances where taxpayers are trying to deduct losses from gambling.
The Americans solved the problem by taking a "heads we win, tails you lose" approach. According to the Internal Revenue Code, taxpayers must report net lottery and gambling winnings as income. They can only deduct gambling losses against gambling income. This solution has the advantage of being certain and predictable. What it lacks is fairness; historically, this was embraced because gambling was considered a vice to be discouraged.
The Supreme Court of Canada has repeatedly insisted that, as a self-assessing system, Canadian income tax law should be certain, predictable and fair. It seems the current unarticulated approach to the taxation of poker winnings is uncertain, unpredictable and unfair.
Benjamin Alarie is an associate law professor at the University of Toronto.